India’s digital readiness: tips on equalization levy
Partner, Tax & Regulatory Services, EY India
Erstwhile American president, John F Kennedy once said, “The problems of this world cannot possibly be solved by sceptics or cynics whose horizons are limited by the obvious realities. We need men who can dream of things that never were.”
Quite rightly so! Under the steadfast leadership of Prime Minister Modi, India's growth story has been difficult to ignore. A series of pro-growth initiatives coupled with favourable economic conditions and resolution of several regulatory bottlenecks have been instrumental in leading the emergence of a ‘New India’. In just a little over two years, the economy has picked up momentum.
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Going by the trends, IMF retains India as the fastest growing large economy and forecasts a robust 7.5 percent growth rate for 2016, underlining India’s economic strength amidst volatile global market conditions. Business climate was reinforced and India jumped 12 spots to secure the 130th rank in the World Bank’s ‘ease of doing business’ index.
Further, investments surged, driving the foreign direct investment rankings, as India steers ahead of China and the US. Amidst these exciting times, a digital revolution is all set to have a profound effect on the lives of its 1.25 billion citizens. For an aspiring digital economy, the benefits are far flung and spread across health, education, labour, industry and services. Yes, India is at a cusp of a technology-led mobile revolution that is fuelling growth of a ‘Digital India’.
Having said that, and to quote the famous American diplomat Benjamin Franklin - “In this world, nothing is certain than death and taxes”
Emergence of the equalization levy
As technology advanced, growth in mobile and electronic commerce gained prominence. As one of the several benefits, many companies were able to create a significant digital presence in a country without being liable to tax. Realising that cross-border transactions on the sale of digital goods and services did not entail any tax obligations, the Indian government felt the need to tax the value created in this digital economy in India. This need, which primarily seeks protection of India’s share of taxes from such digital transactions, bought the concept of an ‘equalization levy’ in consideration.
Taking forward the considerations first proposed in the Organisation for Economic Co-operation and Development’s (OECD) Action Plan 1 of the ‘Base Erosion and Profit Shifting’ (BEPS) Action Plan, the Finance Minister Arun Jaitley proposed an equalization levy on certain transactions as a part of the Finance Bill. This levy is essentially an option to tax digital transactions in a bid to equalize tax burden on remote and domestic suppliers of digital goods and services.
Effective from 1 June 2016, a levy of 6 percent on gross consideration is applicable on payments made to Non Residents (not having significant economic presence in India) for specified digital services and facilities provided to the domestic residents. The provisions are applicable on B2B transaction where the aggregate annual consideration is more than Rs 1 lakh. Further, according to the norms, once this levy has been deducted on a transaction, the consideration paid to the Non Resident will not be liable to further income tax.
A quick assessment of the impact
In layman terms, this is what we are looking at - In the pre-levy scenario, there may be no tax implication on B Limited, a Non-Resident mobile application developer based in UK, for offering services worth Rs 100 to A Limited.
Now, with the imposition of the equalization levy, A Limited will need to withhold Rs 6 on such consideration and deposit the same into the government treasury and pay the remaining Rs 94 to B Limited. If however, the contract specially fixes the equalization levy burden on the Indian business house, A Limited will have to deposit Rs 6.38 with the government treasury and pay Rs 100 to B Ltd.
In a different scenario, had A Limited paid any such consideration to C limited, which is the Indian arm of B Limited, no withholding for equalization levy would be made. However, should C Limited later remit such consideration to B Limited, the same would be liable to an equalization levy.
‘Specified services’ continue to raise concerns
Currently, the levy applies on consideration paid towards ‘specified services’ including online advertisement, provision of digital advertising space, provision of any facility or service for online advertisement, any other service as may be notified.
Given the sweeping definition of ‘specified services, it appears that the scope is expected to expand gradually in due course. Further, the definition of ‘online’ which includes services through any other digital or telecommunication network is misleading and may potentially extend to advertisement on Foreign TV Channels considering most are on digital networks.
The inclusion of ‘other notified services’ may further entail expanding the scope to various online and mobile applications, given it’s a thriving market of its own. Since the entire process is intricately linked with connectivity and electronic communications, the telecoms industry may play a pivotal role in the rendition, control and regulation of such digital services and ultimately in the collection of the levy.
An additional levy means more financial obligations and further tax compliances.
The introduction of equalization levy to tap on the tax leakages in the economy comes as an additional burden and has created a lot of stir amongst the digital service providers. The levy will lead to emergence of tax compliances and financial implications for those firms falling under its remit. To elaborate, companies would need to follow tax compliances including - deposit levy on monthly basis, filing separate annual statements and compliance under I-T Act in cases where value of services less than Rs 1 lakh.
From a financial standpoint, any non-compliance will result to an Interest of 12 percent annually; penalty for failure to deduct, deposit or file annual statement; prosecution of up to 3 years including fines; and disallowance of expense.
Challenges in the way forward
Till further clarifications are issued, the provisions as it stands have raised a lot of issues. For instance, the levy is separate from Income Tax which entails that it is not part of international tax treaties and the levy as withheld is not creditable in the home country.
Similarly there are several considerations that would requiring clarity for greater transparency on the subject. These include:
1) The statement ‘provision for any facility or service for the purpose of online advertisement’ is ambiguous especially under support functions such as development of material for online advertisement, payment to celebrities, etc, specifically for online advertisements. It remains to be seen if this would be covered under the ambit.
2) Determining ‘effective connection’ to a Permanent Establishment [PE] of a Non-Resident [NR] in India, particularly in the digital economy involving servers, hardware and software being run remotely in remote locations
3) Whether a Non Resident should consider conceding a PE in India in order to manage global tax leakages
4) Where EL is paid but later held not to be appli cable (due to a PE of the NR recipient in India or otherwise the service is treated as a non-specified services), no provision for refund of EL
5) The forms of digital network should get covered given the broad definition of ‘online’
6) Differential tax treatment envisaged where a specified service does not attract EL being less than the threshold limit of INR 1 lakh but gets covered under the FTS / Royalty provisions of the IT Act
7) For payment/considerations that cross the specified limit of INR 1 lac, whether the payer is required to deduct EL on consideration/payment already made and the timing thereof
8) Eligibility of EL as an expense for the recipient in the home country
9) Credit of EL against home country taxes of recipient?
10) Where EL is grossed up, whether the grossed up amount eligible for deduction as an expense.
11) Whether cross charges from group entities in relation to specified services be subject to the levy.
12) No provision for Advance Ruling or appeal against the EL. This is significant given the sweeping and ambiguous definition of ‘online’ and ‘specified services’, will surely lead to disputes.
Consumers to shell out more for services
If accepted the way it is, and if all the services provided through internet or telecoms medium are imposed an equalization levy, the bottom lines of several giants that earn significant ad revenues from business entities in India will be facing the heat. As a levy separate from the income tax, it serves as an added tax liability for multinational companies.
Ultimately, this burden is likely to be passed on to the consumers who will bear the brunt of the increased cost of doing business in India. On the positive side, the imposition of this levy would assist in bringing clarity in terms of tax cost of such transaction and may also help in reducing disputes with the tax department on taxability of such transactions.